British GDP Growth

January 25, 2011

The U.K. economy contracted 0.5% (about 2.0% annualized) in the final quarter of 2010 following four straight quarters of post-recession expansion.  Analysts had anticipated a 0.3-0.5% advance instead, down from 0.7% in 3Q and 1.1% in 2Q.  Over those two quarters, GDP had risen at a robust annualized pace of 3.7%.  Unseasonably bad weather depressed construction by 3.3% in 4Q and also weighed on service sector activity, which fell 0.5%.  Services capture personal consumption, which ought to have benefited from spending to beat the 2.5 percentage point (ppt) value added tax increase at the start of 2011. The government believes that GDP would have been roughly unchanged if the negative weather effects had not happened but stresses that’s a highly preliminary guesstimate.  Even allowing for the weather and assuming such is a temporary factor, economic growth last quarter was considerably weaker than anticipated.  The breakdown of the 0.5% GDP drop shows negative contributions of 0.4 ppts from services and 0.2 ppts from construction, mitigated by a 0.1 ppt boost from production.  Services and construction had enhanced third-quarter growth by a combined 0.6 ppts, so the adverse swing between 3Q and 4Q from those two components was around 2.5 percentage points at an annualized rate.

Bank of England policymakers are in a very difficult spot.  With CPI inflation presumably climbing soon to 4-something percent, twice the mandated target, pressure had been mounting for a rate increase this year and preferably in the first half.  The reason to hesitate was the massive dose of fiscal restraint over the coming four years.  It is now apparent that the economy cooled sharply just ahead of the first big wave of that restraint, and after plunging nearly 5% in 2009, real GDP rose just 1.5% last year.  The central bank appears to be in a no-win situation.

Whatever happens to the British economy in 2011 is being watched by governments everywhere.  Politicians in advanced economies have been divided over whether to make reducing the budget or promoting recovery the higher priority in the short run.  Under a new government elected last May, Britain is following the deficit-reduction now mandate more aggressively than anyone else.  The United States represents the other end of the policy spectrum, but not without considerable controversy as the Tea Party’s emergence attests.  Since both ideologies are getting tested, how different economies perform in 2011 and beyond will provide a great learning experience for policymakers in the future.  Unfortunately, no advanced economy government is really doing what economists believe to be the optimal approach, namely a comprehensive multi-year fiscal strategy that encourages growth this year but that simultaneously locks in substantial restraint on both the spending and revenue side in later years.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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